Description

Strategic Financial Management
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Internal Assignment Applicable for April 2018 Examination
Strategic Financial Management
1. A company is evaluating a proposal to replace a machine costing Rs. 800000 and having a written down value of Rs. 400000. The machine has a remaining economic life of 5 years after which it will have no salvage value. However, if sold today, it will fetch an amount equal to its book value. The new machine is expected to cost Rs. 1400000. It is also expected to have a life of 5 years with a scrap value of Rs. 400000. Owing to its technological superiority, the new machine is expected to contribute additional annual benefit (before depreciation and tax) of Rs. 400000. The company s opportunity cost of capital is 10%. The tax rate applicable to the firm is 30%. The company follows Straight Line Method of Depreciation for its machines. Should the company replace the old machine with the new one? (10 Marks)

2. The country s leading oil company is planning to set up a Greenfield project to carry out exploration work in a recently identified prospective site. Keeping the high risks associated with this project in mind, funding the project is turning out to be tricky issue for the company. You, being a subject specialist, have been approached by the company to assist it in project funding. Identify the possible sources of fund for this Greenfield project. Also, guide the company through the various stages involved in the project financing. (10 Marks)

3. A) A company is considering an investment of Rs. 500 million in a project. Expected earnings before interest and tax (EBIT) are Rs. 150 million per year. The operational risks associated with the project are fairly low, and EBIT is expected to remain steady during the project tenure. The company can raise equity, 14% preference shares, 10% debentures, or any combination thereof. Face value of equity shares is Rs. 100. Tax rate is 30%. The company is exploring the following four financing options:
Issue equity capital at par value
Raise 50% by equity share capital and 50% by preference capital
Raise 50% by equity share capital, 25% by preference capital, and 25% by debenture
Raise 25% by equity share capital, 25% by preference capital, and 50% by debenture
Identify the best financing option for the company.
3. B) Which of the above four options will be the best, if the expected EBIT is only Rs. 60 million per year, everything else remaining the same?
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